German generation game leaves the Eurozone's future in doubt
With Greece, Ireland and Portugal in effective insolvency and restructuring their sovereign debt, serious questions are being asked about the future of the Eurozone. Fred Moore, alternate manager of the Newton European Higher Income Fund, looks at the role of Germany, and the political will of a generation of German politicians increasingly at odds with their electorate, in the future of the single currency.
"At the risk of exaggeration, two dominant themes course through the veins of this generation of Germany's leaders," explains Moore. "The first is a belief that Germany should promote and pursue peaceful, democratic and multilateral solutions to domestic and foreign issues; this is a direct consequence of the Second World War and is reflected in Germany's federal make-up, small army, as well as its position as the foundation stone of the great liberal economic project that is the EU. The second is a deeply engrained fear of inflation, as many historians argue hyperinflation fuelled the conditions which led to the extreme politics of national socialism in the 1920s and 1930s," he adds.
"There is now a fascinating tension between these two strands of political thought. If Germany blithely rides to the rescue of the periphery of the Eurozone, it risks inflation through effectively turning on the printing presses to bail out the indebted governments," he says. "If Germany doesn't do anything to rescue the periphery, the Eurozone and perhaps even the EU is at risk of breaking up, risking a collection of failed states on Europe's borders and the potential security concerns that might result. Behind their noble aspiration to keep the European dream alive lies one other, more prosaic, pressure; German banks, already undercapitalised, hold large quantities of peripheral debt on their balance sheets," Moore adds.
"And so Germany's leaders try and opt for the middle way, telling the profligate periphery that if they want to stay as members of the Eurozone club they must tighten their belts and play by the rules." Moore continues, "Only then will Germany resort to lending a helping hand, in the hope that this can be with only limited resort to monetary easing and the resulting inflation risks. Meanwhile, a weaker euro is boosting Germany's extraordinary export machine even further."
A changing of the guard?
"However, the German electorate, increasingly youthful and another generation removed from the war, see no reason why their hard-earned money should go to those who, in their view, do not deserve it," he says. "Why should they pay for the very generous early retirement of an Athens civil servant? The truth is that they are seldom told of the enormous cost of bailing out the German banks should the Eurozone break up. Nevertheless, they are an increasingly vociferous electoral contingent, and politicians tend to listen to the voters close to elections," says Moore.
"It's not just Germany which is capable of throwing a spanner into the works. In Finland, the nationalist and anti-euro ‘True Finns' party has just won 19% of the vote. The Finnish parliament could theoretically veto the latest EU bail-out package," he explains. "That said, ultimately the German pro-European lobby will probably muddle through, and it is unlikely the Eurozone will break up, at least not in the near term. However, it will not be easy, and we expect this to play out for some time yet.
"Despite the barrage of concerns over sovereign debt issues, among global equity markets Europe is one of the best performing regions so far this year. There is a multitude of world-class companies that are quietly getting on with the business of selling things people want to buy," Moore concludes, "investors should not lose sight of this fact."